# 1Jn tbe mtntteb $tates <teourt ofjf 

# eberal <telaims No. 15-20T (Filed: August 16, 2017) 

# FILED
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## * * GREGORYALAN HANN AND 

## * BARBARA CHILDS HANN, 

### * 

## * Plaintiffs, 

### * 

## * v. 

### * * THEUNITED STATES, 

## * * Defendant. 

## * * ************************* * AUG 1 6201 7 U.S. COURT OF FEDERAL CLAIMS 

### TaxRefund Suit; 26 U.S.C. 

### §83; 26 C

.F

.R. 

### § 1.83-7; Nonqualified Stock Options; Cashless Option Exercise; Initial Public Offering (IPO); Underwriters' Commission; CapitalLoss.

Gregory Hann and BarbaraChilds Hann, VirginiaBeach, Virginia, prose.
David 

### A. Hubbert, David I. Pinlrus, Mary M. Abate, and Jason S. Selmont, U

.S. Department ofJustice, Tax Division, Court ofFederal Claims Section, P.O. Box 26 BenFranklin Station, Washington, D.C., 20044, for Defendant.



### OPINIONAND ORDER
WILLIAMS,Judge

. This matter comes before the Court onthe parties' cross-motions for sununaryjudgment. Plaintiffs pro se, Gregory Alan Hann and Barbara Childs Hann, seeka refund ofincome tax paid for the 2011 tax year. Plaintiffs seek to recharacterize as an ordinary expense the Underwriters' commission paidby Mr. Hanninconnectionwithhis participation inhis employer's initialpublic offering. As a matter oflaw, the Underwriters' commission inthis case is properly characterized as a capital expense because itwas paid to sell a capital asset

- - the stockacquired by Mr. Hann inexercisinghis stockoptionsto participate inthe initialpublic offering

. As there is no genuine dispute ofmaterial fact, summaryjudgment is granted in favor of Defendant.



### 7017 1450 ODDO 1346 3912Background 1 Duringthe relevanttax years, Mr. Hannwas ExecutiveVice President and ChiefFinancial Officer ("CFO") ofWesco Aircraft ("Wesco"). On January 29, 2009, while still a privately held companywhose shares werenot soldonan established securitiesmarket, Wesco grantedMr. Hann 65,574 stock options as compensation. 2 Each optionrepresented the right to acquire one share of Wesco common stock ("option shares"). The initial exercise price was $64.96 per share. On October 28, 2009, some 10 months after the options were granted, the stock option agreementwas amended, and the exercise price decreased to $56.64 per share. When Wesco granted the options, there were no restrictions ontheirexercise beyond the vesting schedule.3 Oncethe options vested, Mr. Hann had full legal rights to exercise the options and acquire the stock. OnJune7, 2011,Wesco'sExecutiveVice President and ChiefLegal Officer,JohnHolland, issued a confidential memorandum to Wesco employees regarding the proposed Initial Public Offering (IPO) Wesco was arranging onbehalfofits primary shareholders, the Carlyle Group and Wesco's ChiefExecutive Office ("CEO"), Randy Snyder. JointEx. 4. TheHollandmemorandum informed employee equity holders, including Mr. Hann, that Wesco would provide them "an opportunityto sell aportion oftheir eligible shares intheproposedoffering alongside"the primary shareholders. Id. However, participating employee equity holders were required to sell the same proportionoftheir shares as the primary shareholders. Id. Therefore,participationrequired option holders to "authoriz[ e] the sale of[their] eligible shares andthe automatic exercise of[their] vested and exercisable stock options

..."to complywith the proportionality requirement. Id. Because ofa lock-up agreement,4 the IPO was the only opportunity for employee equity holders to sell any Wesco shares without waiting until 180 days after the !PO. Id. The Holland memorandum made explicit that the employee equity holders' participation in the !PO was
This background is derived from the parties' stipulation of facts and exhibits and the exhibits attached to Defendant's motionfor summaryjudgment.
2 The Wesco Holdings, Inc. Equity Incentive Plan Stock Option Agreement Grant Notice granted Mr. Hann both nonqualified stock options (i.e. ordinary options) and incentive stock options. See Jt. Ex. 14. Mr. Hann exercisedhis nonqualified stock options in the transaction. Jt. Ex. 9.
3 Ofthe 65,574 options grantedto Mr. Hann, 16,393 optionsvested onatime-based schedule (i.e. after Mr. Hann worked for a specifiedperiod), with one-third ofthe options vesting annually on September 30of2009, 2010 and 2011. Jt. Ex. 14. The remaining 49,181 options vested on a performance-based schedule. Id.
4 Lock-up agreements bar existing shareholders from selling additional shares for a defined period after the !PO. Lock-up agreements are "common, even essential, to the typical IPO" because they assure potential buyers ofthe !PO's securities, that additional shares owned by the "pre-IPO shareholders ofthe issuer will not enter the public market too soon after the offering." Lowinger v. Morgan Stanley & Co. LLC, 841 F.3d 122, 131 (2d Cir. 2016)(intemal citations and quotationmarks omitted). "These assurances lead investorsreasonablyto expectanorderlymarket free ofthe danger oflarge sales ofpre-owned shares depressing the share price before the pricing ofthe newly offered shares has settled inthe market." Id.

2

### "optional and voluntary." Id. Mr. Hann was aware that his participation in the IPO was optional and that he could still exercise his options after the expiration ofthe 180-day "lock-up period." As Wesco's Chief Financial Officer, Mr. Hann was significantly involved in the IPO process. Hann Dep.; Tr. 25. Wesco issuedand filed withthe Securities and Exchange Commission the Prospectus for the proposed IPO on July 27, 2011. In the Prospectus, Wesco represented that the selling shareholders were offering 21,000,000 shares ofWesco common stock in this offering and that Wesco would not receive any proceeds from the sale ofthe shares held by the selling stockholders. Def.'s Ex. 4. Wesco also represented:

• the public offering ofthe price ofthe stock would be $15 per share;

• the underwriting discounts and commissions would be $0.8625 per share; and

• the proceeds to the selling shareholders would be $14.1375 per share. Id. Wesco "agreed to pay expenses incuned by the selling stockholders in connection with the offering, other than the underwriting discounts and commission." Id. Mr. Hann elected to participate in the IPO. Wesco ananged for a "cashless exercise," whereby participating option holders did not pay the exercise price out ofpocket. Rather, "the exercisepricewas deductedfrom the compensationthe participantreceived fromthe Underwriters. Holland 30(b)(6) Dep. 16.5 

### To achieve this cashless exercise and paiiicipate in the IPO, Mr. Hann executed four documents prior to the July 28, 2011 IPO

- - a Power of Attorney, an Exercise Notice, a Custody Agreement, and a Lock-Up Agreement. The Power of Attorney authorized Mr. 

### Hann (acting as a Wesco executive, not in an individual capacity) and a second Wesco executive (the "Attorneys") to sell to the Underwriters up to the "MaximumNumber ofOptional Shares

...represented by the Book-Entry credits placed in escrow or the Exercise Notices deposited by [Mr. Hann] with the Custodian pursuant to the Custody Agreement

... at apurchasepriceper share to be paidbythe Underwriters, as determined by negotiation

... "between Wesco and the representatives ofthe Underwriters. Joint Ex. 10. The "Maximum Number ofOptional Shares" was 39,167.63 (determined prior to a stock split), roughly 60 percent ofMr. Hann's Shares ofCommon Stock Subject to Option. JointEx. 11. The Exercise Notice notified Wesco that Mr. Hann exercised the vested portion of his options "in connection with the Company's anticipated initial public offering

... contingent upon the inclusionofthe shares

... in the offering contemplated

... [in an amount to] be dete1mined by the Attorneys

...."6 

### JointEx. 9. The ExerciseNotice directedthatthe "fullamount ofthe exercise price necessary to exercise [Mr. Harm's] Vested Options and any applicable tax withholding obligations be deducted from the net proceeds [Mr. Hann was] entitled to receive from the

5 

### "Holland 30(b)(6) Dep." refers to John Holland's Rule 30(b)(6) deposition on behalfof Wesco Aircraft Holdings, Inc. rather than his individual deposition.

6 

### Mr. Hann exercised his nonqualified stock options in the transaction.

3subsequent sale ofsuch Shares to certain Underwriters, as specified in the Custody Agreement." Id. The Custody Agreement directed that the IPO Custodian retain "Exercise Notices" delivered by Mr. Hann and required Mr. Hann to concurrently execute an irrevocable power of attorney authorizing the Attorneys to sell up to the number ofshares ofcommon stockrepresented byhis Exercise Notices and to enter an underwriting agreement in order to sell the shares on Mr. Harm's behalf. JointEx. 11. Uponthe closing date specified inthe UnderwritingAgreement, the Custody Agreement directed the Custodian to (i) exercise the number ofoptions subject to the Exercise Notices to the extent necessary to provide the "Maximum Number ofShares" (i.e. the number of shares necessary to meet the proportionality requirement) to the Underwriters, (ii) transfer the option stock to the Underwriters, (iii) receive payment for the option stock from the Underwriters, (iv) pay the exercise price from the amount received from the Underwriters, (v) remit the balance to Mr. Hann, and (vi) furnish Mr. Hann a Fonn 1099 reflecting the transaction by January 31 ofthe following tax year. Id. The "Lock-Up Agreement" restricted Wesco equity holders, like Mr. Hann, from (1) offering, pledging, selling, contractingto sell, selling an optionorcontractto purchase,purchasing an optionorcontractto sell, granting any option, right orwarrantto purchase, lending, orotherwise transferring or disposing of, directly or indirectly, any common stockthey beneficially owned, or (2) entering into any swap or other arrangement that transfers to another, in whole or in part, any ofthe economic consequences ofownership ofthe Common Stock for 180 days after the IPO. Joint Ex. 8. The "cashlessexercise"describedbyMr. Hollandtookplace inseveral distinctsteps. First, theprimary shareholders, in conjunctionwith the Underwriters, determinedtheproportion oftheir interest in Wesco they would sell and those shares' market price. Immediately prior to the IPO, Wesco undertook a nine-way stock split. Joint Stip. 

## if 10. Each share was priced by the Underwriters for public purchase at $15 per share. Id. at

## if 9. Corresponding with the stock split, Mr. Harm's options increased ninefold, from 65,574 to 356,558 options, and his option exercise pricewasreduced to one-ninththe existingprice, from $56.64per share to $6.29333 per share. Id. at

## iii! 4-5, 8, 10. On July 28, 2011, immediately prior to the IPO, the participating shareholders, including Mr. Hann, sold their sharesto the lead Underwriters, Barclays Capital Inc. and Morgan Stanley & Co., LLC (the "Underwriters") for $14.1375 per share (a discount to their $15 fair marketvalue). Id. at 

## ifif 11, 14. Pursuant to the Custody Agreement, Mr. Harm's Attorneys exercised 89,139 options onMr. Harm's behalfand immediately soldthese 89,139 shares to the Underwriters, who paid Mr. Hann $14.1375 per share. Id. at 

## if 18; Joint Ex. 5. The Underwriters then sold these shares to the public at $15 per share, taking a "commission" of $0.8625 per share (the "Underwriters' commission"). Joint Stip. 

## ifif 14; Def.'s Ex. 4 ("The underwriting fee is the difference betweenthe initialprice to thepublic and the amountthe underwriters payto the selling stockholders for the shares."). Mr. Hann did not take physical custody ofany shares pursuant to his participation in the IPO. Joint Stip. 

## if 14. However, as Mr. Holland acknowledged, to participate in the IPO Mr. Hann needed to exercise his options and receive shares. Holland Dep. 19, 30. All ofthe selling shareholders received from the Underwriters the netproceeds (the gross, fair marketprice less the Underwriters' commission) for their shares. Joint Stip. 

## if 14. Forthe sale



### 4of Mr. Hann's 89,139 shares at $15 per share, the gross proceeds were $1,337,085. The Underwriters' commission of$0.8625 per share for 89,139 shares amountedto $76,882.39. Id. at 

### if 20. Therefore, the net proceeds from Mr. Hann's sale ofstockto the Underwriters, $1,260,202, was deposited into Mr. Hann's Morgan Stanley Smith Barney account. Joint Exs. 5, 6. Wesco issued Mr. Hann a W-2 for the 2011 tax year reporting ordinary income from the IPO of$776,103.56. Joint Ex. 7. This amount corresponds to the gross proceeds received in the IPO, $1,337,085, less the option exerciseprice, $560,981.44. On April 15, 2012, Plaintiffs filed a year 2011 tax return treating the $776,103.56 reported on the W-2 as ordinary income and the $76,882.39 Underwriters' commission as a short-term capital loss. JointEx. 1. On April 19, 2012, Plaintiffs filed an amended individual income tax return (Fonn 1040- X) for tax year 2011, reporting the Underwriters' commission as a reduction ofgross income, and requesting a $26,908 refund. JointEx. 2. Plaintiffs provided an explanation, stating: In June 2011, Wesco Aircraft had an initial public offering. As part of this transaction, taxpayer exercised certain nonqualified stock options. The difference between the stock's fair market value at time ofexercise and the option price was included in taxpayer's W-2 income. However, taxpayer was required to pay the Underwriters' commission as paii of this overall transaction. This $76,882 of commission paid by the taxpayer is in fact part ofhis required cost to exercise the optionthroughthe public offering. As such, this amount should reduce taxpayer's W-2 income as reflected inthis tax return. JointEx. 2. OnJune 10, 2014, the Internal Revenue Service ("IRS") disallowed Plaintiffs' refund claim for tax year 2011. Joint Stip. 

### if 23. Plaintiffs filed the instant action on January 8, 2015. This Courtheld oral argument onthe cross-motions for summaryjudgment onApril 10, 2017, and the parties filed supplemental briefs on May 10, 2017 and May 22, 2017. Discussion Jurisdiction The United States Court ofFederal Claims is authorized to adjudicate tax refund claims under the Tucker Act. 28 U.S.C. § 149l(a)(l) ("The United States Court ofFederal Claims shall havejurisdictionto renderjudgmentupon any claim against the United States founded eitherupon the Constitution, or any Act ofCongress or any regulation ofan executive department

... in cases not sounding in tort."). Section 7422 of the Internal Revenue Code governs the procedural requirements for such cases. Wolens v. United States, 125 Fed. Cl. 422, 426 (2016). "Taxpayers must first paythe assessed tax in full and file a tax refund claim withthe IRS before bringing suit in federal court." Id. (citing 26 U.S.C. § 7422(a)). "Ifthe refund claim is denied, the taxpayer generally must file suit within two years, and then may only raise the claims and arguments previously presentedto the IRS." Id. (internal citations omitted). Here, the Plaintiffs fully paid the income tax for 2011, properly filed a refund claim with the IRS, and timely filed a suit in this Court.



### 5Legal Standard for Summary Judgment


### In granting a motion for summaryjudgment, a court must find that there is no "genuine dispute as to any material fact and the movant is entitled tojudgment as a matter oflaw." RCFC 56(a). A genuine dispute is one which "may reasonably be resolved in favor of either pmiy." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250 (1986). A fact is material ifit "might affect the outcome ofthe suit

...." Id. at 248. The moving party bears the burden ofestablishing the absence ofany genuine issue ofmaterial fact. Mingus Constructors, Inc. v. United States, 812 F.2d 1387, 1390 (Fed. Cir. 1987). Once the burden is met, the onus shifts to the non-movant to point to sufficient evidence to show a dispute over a material fact that would allow a reasonable finder offact to rule in its favor. Liberty Lobby, 477 U.S. 256-57. When considering a motion for summary judgment, the court draws all factual inferences in a light most favorable to the nonmoving party. Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Com., 475 U.S. 574, 587 (1986).When opposing parties both move for summaryjudgment, "the court must evaluate each party's motion on its own merits, taking care in each instance to draw all reasonable inferences against the party whose motion is under consideration." Mingus, 812 F.2d at 1391. At the summaryjudgment phase, the court may not weigh any evidence but only "determine whether there is a genuine issue for trial." Liberty Lobby, 477 U.S. at 249. The Underwriters' Commission Is Properly Characterized as a Capital Loss 

### The parties stipulated to all material facts. At issue is the proper tax treatment ofthe Underwriters' commission. Plaintiffs argue that the Underwriters' commission was properly deductible from their 2011 ordinary income, entitlingthem to the $20,116 refund claimed ontheir amended return. 7 

### J. Ex. 2. They posit four alternative theories. First, Plaintiffs argue the transaction, in which Mr. Hann exercised his options and received cash, was a single-step transaction. Pis.' Mot. 2-3. Second, Plaintiffs argue that Mr. Hann paid the Underwriters' commission in order to exercise the options, entitling them to reduce the amount realized under either 26 U.S.C. § 

### 83 or 26 U.S.C. § 

### 1012. Comp!.**~~** 

### 6-7, 12-13, 15; Pis.' Mot. 3-4. Third, Plaintiffs arguethe Underwriters' commissionwas an ordinary andnecessary expenditure incurred in a trade or business, deductible from gross income under 26 U.S.C. § 162.**Comp!.~** 

### 8, 14; Pis.' Mot. Fourth, Plaintiffs make a "substance over form" argument, asserting that because they paid the Underwriters' commissionto generate ordinaryincome, the expense shouldbe deductible from ordinary income, and the form ofthe transaction should be disregarded. Pis.' Mot. 5. Defendant argues that the Underwriters' commission was a cost incurred to sell the stock acquired by exercisingthe options onthe public market and is properly characterized as a capital loss under 26 U.S.C. § 

### 1011. Def.'s Mot. 1-2. Mr. Hann realized ordinary income upon receiving the options and was required to recognize as ordinary income the fair market value ofthe option shares received less the exercise price paid. In a separate taxable step, to participate in the IPO, Mr. Hann sold that stock to the Underwriters,paidthe Underwriters' commission, and receivedthe fair marketvalue ofhis shares. The Underwriters' commission is properly treated as a reduction in the mnount realized on Mr. Hann's sale ofthe stockto the Underwriters. Because the Underwriters' commissionreduced the

7 

### In their complaint, Plaintiffs seek $26,908.

6sale price to an amount below Mr. Hann's basis in his shares, the difference is properly characterized as a capital loss, which cannot offset ordinary income beyond $3,000 annually. 26 U.S.C. § 121 l(b)(l) (2016). Step (1): Mr. Hann Received Ordinary Income When He Exercised His Options An employee who receives nonqualified stock options as compensation for services performed realizes ordinary income. 26 U.S.C. § 83(a) (2016); see also Comm'r v. LoBue, 351 U.S. 243, 247 (1956) ("When assets are transferredbyan employerto an employeeto securebetter services they are plainly compensation. It makes no difference that the compensation is paid in stock [options] rather than in money."). However, ifthe options lack a readily ascertainable fair market value at grant, the employee does not immediately recognize income. 26 U.S.C. § 83(e) (3). Instead, the employee recognizes income upon exercisingthe option. 26 C.F.R. § l.83-7(a). When an employee exercises nonqualified stock options, the employeemust include inhis gross income the difference between the option stock's fair market value at exercise and the "amountpaid"to acquire the option stock. 26 U.S.C. § 83(a)(l). "[T]heterm 'amountpaid' refers to any amount paid for the grant ofthe option plus any amount paid as the exercise price ofthe option." 26 C.F.R. § !.83-3(g) (2014). As part of his 2009 employee compensation, Mr. Hann received nonqualified stock options. Mr. Hann did not pay any additional amount for the grant ofthe option. When Wesco granted Mr. Hann these stock options, it was a privately held corporation, and its stock was not sold on an established market, and had no "readily ascertainable fair market value." 26 C.F.R. § 1.83-7(b)(2). As the options lacked a readily ascertainable fair market value at grant, they were not taxable uponreceipt. 26 U.S.C. § 83(e)(3). Plaintiffswere therefore notrequiredto recognize as income the fair market value ofthe stock options Mr. Hann received as compensation in 2009. Instead, Plaintiffs deferred income recognition until Mr. Hann exercised the options. 26 C.F.R. § l.83-7(a). To patiicipate in the IPO, Mr. Hann placed an Irrevocable Exercise Notice in escrow and authorized his Attorneys to exercise his options as required by the Underwriting Agreement. Mr. Hann's Attorneys exercised 89,139 options on his behalf, pursuant to the proportionality requirement determined by the primary shareholders upon finalizing the IPO. As a result, the Attorneys received from Wesco 89,139 shares on Mr. Hann's behalfthat they immediatelyresold to the Underwriters. Mr. Hann was the beneficial owner ofthese 89,139 shares the Attorneys received. Therefore, at the time of exercise, Plaintiffs were required to recognize as ordinary incomethe difference betweenthe option stock's fairmarketvalue at exercise and the amountpaid to acquire the option stock. 26 C.F.R. § l.83-7(a); 26 U.S.C. § 83(a).

7On the exercise date, the 89,139 Wesco shares' fair market value was $15 per share, 8 or $1,337,085 total. The amount paid to acquire the option stock was the $6.29333 per share,9 or $560,981.14 total. 26 C.F.R. § l.83-3(g). Therefore, Plaintiffs were required to recognize as ordinary income $8.70667 per share ($15 less $6.29333), or $776,103.88 total

- the amount reported by Wesco on Mr. Hann's 2011 W-2. Joint Ex. 7. This was the first taxable step in Mr. Harm's !PO participation. Step (2): Mr. Hann Generated a Capital Loss By Selling His Wesco Shares to the Underwriters The tax consequences ofa capital asset transaction govern the second taxable step in Mr. Hann's !POparticipation. A capital asset is anypropertynotenumerated in 26 U.S.C. § 122l(a). 10 Stockina corporation is a capital asset as it is not so enumerated. 26 U.S.C. § 1221(a) (2016); see also Ark. Best Com. v. Comm'r, 485 U.S. 212, 217-18 (1988). Unless otherwise provided in the Internal Revenue Code, a taxpayerrecognizes all gain or loss upon the disposition ofproperty. 26 U.S.C. § lOOl(c) (2016). The taxpayer must include in gross income all gain recognized from the disposition of property. Id. § 6l(a)(3) (2016). Individual taxpayers may deduct from gross income any loss recognized in a transaction entered into for profit. Id. at § 165(a)-(c) (2016). However, individual taxpayers may generally only deduct a capital loss from gross income to the extent ofcapital gain recognized in that tax year. Id. at§§ 165(f), 121 l(b). When capital losses exceed capital gains in a given year, an individual taxpayer may further deduct a maximum of $3,000 in that tax year. Id. at 121 l(b)(l). Any remaining capital loss converts into capital loss carryover and carryback, which can offset capital gain inpast and future tax years. See id. at§§ 172 and 1212(b).

8 The Underwriters determined this fair market price of the Wesco shares m the simultaneously occun"ing !PO.

9 Per 26 C.F.R. § l.83-3(g), this "amount paid" represents the $6.29333 per share exercise price plus $0 paid for the option grant. However, Mr. Hann did not pay the exercise price out of pocket, the Underwriters paid itto Wesco onhis behalffrom Mr. Hann'sproceeds from the !PO.

10 Enumerated non-capital property includes (1) stock in trade properly included in the taxpayer's inventory orheld by the taxpayerprimarily for saleto customers inthe ordinary course ofhis trade or business and accounts or notes receivable acquired from the sale thereof; (2) trade or business property depreciable by the taxpayerunder 26 U.S.C. § 167 and real property used by thetaxpayerin atrade orbusiness; (3) copyrights, literary, musical, orartistic compositions, letters or memoranda, or similar property held by certain taxpayers; (4) accounts or notes receivable acquired for services rendered in the ordinary course oftrade or business; (5) U.S. Government publications received from the goverrnnent by certain taxpayers at a price other than that offered to the public; (6) any commodities derivative financial instrument that fails to meet certain requirements and is held by a commodities derivatives dealer; (7) certain hedging transactions; and (8) supplies ofa type regularly used or consumedbythe taxpayerinthe ordinary course ofthe taxpayer's trade or business. 26 U.S.C. § 1221(a) (2016).

8Mr. Hann acquired 89,139 Wesco shares when his Attorneys implemented the Exercise Notice and CustodyAgreement, pursuantto the Underwriting Agreement. Mr. Hann is not inthe trade or business ofselling securities, and Mr. Hann's Wesco option shares were a capital asset. 26 U.S.C. § 1221(a). Contemporaneously withexercising Mr. Hann's options- butin a separate, taxable step

- the Attorneys sold Mr. Hann's 89,139 Wesco shares to the Underwriters on Mr. Hann's behalf. Upon the disposition ofMr. Hann's shares to the Underwriters, Plaintiffs realized a capital loss to the extent their basis in the Wesco shares exceeded the amount realized on the sale. Id. at§ IOOl(a). On the sale, Plaintiffs realized $15 per share in the fair market value ofthe option stock paid by the Underwriters. However, because Mr. Hann paid the Underwriters' commission as a cost ofparticipating in the IPO and selling his Wesco shares, Plaintiffs must reduce the amount realized by the $0.8625 per share for the Underwriters' commission, to a net amount realized of $14.1375 per share, or $1,260,202.61. The Underwriters' commission was incurred by all IPO participants to sell the Wesco stock to the Underwriters, and was a capital expense. Davis v. Comm'r, 151 F.2d 441, 443 (8th Cir. 1945), cert. denied, 327 U.S. 783 (1946) (Underwriters' commissions paid by a principal shareholderpursuant to an IPO are a capital expense paid to sell the stock). "Ithas long been recognized, as a general matter, that costs incurred inthe acquisition or disposition ofa capital asset are to be treated as capital expenditures." Woodward v. Comm'r, 397 U.S. 572, 575 (1970). As Plaintiffs' basis inthe shares exceeded the amount realized on the sale to the Underwriters by $0.8625 per share, Plaintiffs realized a capital loss of$76,882.39, the amount ofthe Underwriters' commission. 26 U.S.C. §§ 165, 1001. However, because Plaintiffs lacked other capital gains in 2011, they were permitted to recognize (i.e. deduct) a maximum of $3,000 as a capital loss. Id. at§ 121 l(b)(l). The Two Steps' Simultaneous Execution Does NotAffect Their Separate Tax Treatment Plaintiffs argue Mr. Hann engaged in a single-step transaction whereby he exercised his options and received cashproceeds. Plaintiffs argue that Mr. Hann never tookpossession ofany stock and his "patiicipation [in the IPO] as a non-qualified option holder did not allow him to receive common st[o]ckupon exercise ofthe options." Pis.' Mot. 1. Therefore, in Plaintiffs' view, the Underwriters' commission should offset Plaintiffs' ordinary income. While Mr. Hann'sparticipation in the IPO didnot entitle himto retain common stockupon exercisinghis options, in orderto participateinthe IPO, Mr. Hannneededto acquire Wesco shares via his options and then immediately resell the shares to the Underwriters. Holland Dep. 12-13, 15-17. Mr. Hann held legal

- if not physical

- ownership ofthe shares when his Attorneys exercised the options onhis behalf. Id. at 19, 29-30. Only after Mr. Hann gained legal ownership ofthe shares couldhis Attorneys sell those shares to the IPO Underwriters. The short duration of Mr. Hann's legal ownership of the Wesco shares did not alter the tax consequences of his ownership and sale ofthe stock. The acquisition ofWesco stock pursuant to his stock options followed by the immediate resale ofthe Wesco stockto the Underwriters was necessarily a twostep transaction. That Wesco agreed to accept payment ofthe exercise price directly from the Underwriters does not changethe taxable steps taken by Mr. Hann.

9The Underwriters' Commission Is Not Governed By§ 83 or§ 1012
Plaintiffs arguethatbecauseMr. Hanncouldnothave exercisedthe optionswithoutpaying the Underwriters' commission, the commission could either be an "amount paid" to exercise the options under 26 U.S.C. §83 or be capitalized in the stock'sbasis under 26 U.S.C. § 1012. Under either scenario, in Plaintiffs' view, the Underwriters' commission should reduce the ordinary incomerealizedfromthe optionexercise,ratherthanthe capital incomerealized onthe subsequent sale ofthe option stock to the Underwriters. Plaintiffs' theoryfails becausepaymentofthe Underwriters' commissionwasnotrequired for Mr. Hann to exercise his options, but was compensation to the Underwriters for valuing and establishing a public market for Wesco stock for the IPO. Contrary to Plaintiffs' assertions, Mr. Hanncouldhave exercisedthe options withoutpayingthe Underwriters' commission, as restricted by the lock-up agreement. !PO participationwas separate and distinct from Mr. Hann's abilityto exercise his options. Ratherthan effect a cashless exercise, Mr. Hann was entitledto exercise the options, pay the exercise price, and retain ownership ofthe option shares in Wesco. See Wesco Dep. at 22; Holland Dep. 15. Mr. Hann could have waited until the expiration of the lock-up periodto sell his Wesco shares so acquired. Joint Stip. 15. Paying the Underwriters' commission was only a condition precedent to Mr. Hann's participating in the !PO, it was not a condition precedentto his exercising the options. Accordingly, Plaintiffs must treat the Underwriters' commission as a capital expense paid to sell the stock and reduce the amount realized on the sale. Spreckles v. Comm'r, 315 U.S. 626, 630 (1942). The Underwriters' Commission Is Not a Business Expense
Plaintiffs argue the Underwriters' commission is an ordinary and necessary expenditure incunedina trade orbusiness, and therefore deductible from gross income under 26 U.S.C. § 162 and 26 C.F.R. 

### § 1.162-1. Section 162(a) permits the deduction of all ordinary and necessary expenses paid in carrying on a trade or business. Plaintiffs claim Mr. Hann's trade or business was being "an executive of Wesco Aircraft" and that the Underwriters' commission was "an ordinary andnecessarybusiness expense directly connectedwiththe exercise ofthe optionand the related generation ofordinary income." Pis.' Mot. 4. Mr. Hann was Wesco's ChiefFinancial Officer; his trade orbusiness was being a Wesco employee. Anindividualmaybeinthetrade orbusiness ofbeing anemployee. 26 C.F.R. §l.162- l7(a); Mitchell v. United States, 408 F.2d 435, 439 (Ct. Cl. 1969) ("[B]eing a corporate official

.

. . constitutes the 'carrying on' of a trade or business within the meaning of section 162(a)."). Exercising his options made Mr. Hann a shareholder in Wesco

- separate from his status as an employee. When he immediately sold his shareholder interest in Wesco to the IPO Underwriters, he sold a capital interest inthe corporation. Anindividual who is both an employee and shareholdermust acknowledgethatdual status and separatelydetermine the taxconsequences ofeach activity. SeeUnited Statesv. Generes, 405 U.S. 93, 100 (1972)(a "taxpayer'sdual status relative to thecorporation

... [as] botha shareholder and anemployee

... occasiondifferenttax consequences."). Expenses associatedwithone'strade or business as a corporate executive are deductible as a trade or business expense. But expenses incurred in one's capacity as a shareholder, where profit comes from appreciation in the value of

10business and distributed earnings, must be allocated to one's capital interest in the corporation. As the Tax Court, citing Spreckles, explained: selling commissions paid in connection with the disposition ofsecurities may not be deducted as ordinary and necessary expenses by one not a dealer in securities, and [these] commissions are to be treated as offsets against the sale price in determining the gain or loss incident to the disposition ofproperty. Davis v. Comm'r, 4 T.C. 329, 333 (1944), affd, 151F.2d441 (8th Cir. 1945), ce1i. denied, 327 U.S. 783 (1946). Because Mr. Hannwas not inthe trade orbusiness ofselling securities, Plaintiffs cannot deduct as a trade or business expense commissions paid to sell securities. Instead, the expenses Mr. Hann incun-ed selling his capital interest in Wesco may offsetthe amount Plaintiffs realized inthe transaction. Spreckles, 315 U.S. at 630. The Substance Over Form Doctrine Is Inapplicable Plaintiffs make a purported "substance over form" argument, positing that the "true economics ofthe transaction" should be reflected in the tax result, allowing them to offset their ordinary income. Plaintiffs argue that "[t]he income generated to the [P]laintiffs is ordinary income and there is no situation in which the exercise ofthese options couldbe treated as a capital gain[,] therefore the expenses required to generate this ordinary income should be ordinary in nature as well." Pis.' Mot. 5. Plaintiffs' focus on the ordinary income generated by the option exercises ignores the second transaction and the economic reality that Mr. Hann sold his Wesco shares and opted to participate in the IPO. The IPO pmiicipants including Mr. Hann paid the Underwriters' commission in orderto sell their shares to the Underwriters, not in order to exercise their options. In short, the true economics ofthe transaction are reflectedinthe tax result Plaintiffs received. Conclusion Plaintiffs' motion for surrunary judgment is DENIED, and Defendant's motion for summaryjudgment is GRANTED.

Judge

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